The Capital Structure Decisions of New Firms∗

Alicia M. RobbUC Santa Cruz

David T. RobinsonDuke University and NBER

May 6, 2010

Abstract

This paper investigates the capital structure choices that firms make in theirinitial year of operation, using restricted-access data from the Kauffman FirmSurvey. Contrary to many accounts of startup activity, the firms in our data relyheavily on external debt sources such as bank financing, and less extensively onfriends and family-based funding sources. This fact is robust to numerous controlsfor credit quality, industry, and business owner characteristics. The heavy relianceon external debt underscores the importance of well functioning credit markets forthe success of nascent business activity.

1 Introduction

Understanding how capital markets affect the growth and survival of newly created

firms is perhaps the defining question of entrepreneurial finance. Yet, much of what we

know about entrepreneurial finance comes from firms that are already established, have

already received venture capital funding, or are on the verge of going public—the dearth

of data on very early stage firms makes it difficult for researchers to look further back in

∗The authors are grateful to the Kauffman Foundation for generous financial support and to seminarparticipants at the Kauffman/Cleveland Federal Reserve Bank Entrepreneurial Finance Conference,the University of Michigan, the Stockholm School of Economics and the NBER Summer InstituteEntrepreneurship Meetings for helpful comments on a previous draft. The usual disclaimer applies.

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firms’ life histories.1 Even data sets that are oriented towards small businesses do not

allow us to systematically measure the decisions that firms make at their founding. This

paper uses a novel data set, the Kauffman Firm Survey (KFS), to study the behavior

and decision-making of newly founded firms. As such, it provides a first-time glimpse

into the capital structure decisions of nascent firms.

In this paper we use the confidential, restricted-access version of the KFS, which

tracks nearly 5,000 firms from their birth in 2004 through their early years of operation.2

Because the survey identifies firms at their founding and follows the cohort over time,

recording growth, death, and any later funding events, it provides a rich picture of firms’

early capital structure decisions.

Our analysis is motivated by the widely held view that frictions in capital markets

prevent startups from achieving their optimal size, or indeed, from starting up at all. In

credit markets, startup firms face credit constraints, and the inability to access formal

credit markets is widely thought to drive many firms to pursue financing from informal

channels to finance their startup activity. This motivation is at the heart of an important

literature in banking that considers the role of relationships in establishing information

flows between banks and firms (see, for example, Peterson and Rajan, 1994, 2000.) The

richness of the KFS data allows us to explore the extent to which startups rely on friends

and family versus more formal financing arrangements, such as bank loans, credit cards,

and venture capital.

Thus, rather than test specific theories of capital structure, our main goal is a more

modest, descriptive one: to examine the financing choices that firms make when they

1Some noteworthy recent exceptions are Kaplan, Sensoy and Stromberg, 2009, which follows a smallsample of firms beginning at business plan stage, and Reynolds (2008) which uses data from individualswho are contemplating starting businesses.

2To be eligible for inclusion in the KFS, at least one of the following activities had to have beenperformed in 2004 and none performed in a prior year: Payment of state unemployment (UI) taxes;Payment of Federal Insurance Contributions Act (FICA) taxes; Presence of a legal status for thebusiness; Use of an Employer Identification Number (EIN); Use of Schedule C to report business incomeon a personal tax return.

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launch, and ask whether any patterns emerge from the data. A null hypothesis is

that idiosyncracies in market conditions and access to financial and human capital are

reflected in a high degree of variability in the capital structure choices that nascent firms

make. Under the null, no pattern would emerge. Rejecting that null in favor a particular

capital structure for startup firms then opens the door to questions about which theories

provide the best account for the observed capital structure choices that startup firms

make.

Our main result is that newly founded firms rely heavily on formal debt financing.

Our calculations indicate that external debt financing—primarily through owner-backed

bank loans and business credit cards—is the primary source of financing during a firm’s

first year. Indeed, our data suggest that the reliance on friends and family is an urban

myth. The average amount of bank financing is seven times greater than the average

amount of insider-financed debt; three times as many firms rely on outside debt as do

inside debt. Even if we discard firms that do not use this source of financing, the average

amount of external debt is nearly twice that of internal debt.

The reliance on formal credit channels over personal credit cards and informal lending

holds true even for the smallest firms at the earliest stages of founding. The average pre-

revenue firm in our sample has twice as much capital from bank loans than from insider

sources. And when we look at only those firms who access outside equity sources, such

as venture capital or angel financing, we still see a preponderance of debt: the average

firm that accesses external private equity markets still has around 25% of its capital

structure in the form of outside debt.

Of course, these calculations only speak to the equilibrium amount of borrowing from

inside and outside sources; they are driven by both the supply of credit as well as the

demand for credit. Ultimately, it is challenging to separate supply and demand in the

absence of a natural experiment. But to control for the fact that differences in firm

quality or creditworthiness may be driving the patterns we see in the data, we make use

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of commercial credit scores of the firms. This gives us two avenues to control for demand-

side variation. The first is simply to include the credit score directly in our analysis as a

proxy for firm quality. Or, by regressing the credit score on industry dummies as well as

firm and owner characteristics that affect the demand for capital (such as the legal form

of organization of the business and the owner’s education), we can purge the credit score

of demand-side variation, leaving us with a measure of supply-side variation in credit

access. Using these strategies to partition the data into firms with easy access versus

constrained access to capital, we can explore how much the capital structure decisions

of nascent firms are driven by supply-side factors.

Surprisingly, this partitioning has little effect on the observed capital structure

choices firms make. To be sure, firms with high unexplained credit scores have more

financial capital. The level of financing of these firms is nearly three times larger on

average than constrained-access firms. But the relative amount of outside debt to total

capital is about the same for both types of firms.

Apart from the possibility that cross-sectional variation in creditworthiness drives

our results, a second possibility is that credit conditions at the time of our survey were

unique, and do not necessarily reflect broader patterns from other time periods. While

ultimately we are limited to the data that are available, we speak to this possibility

by considering the impact of capital structure decisions on outcome variables like firm

survival, employment growth, and profitability growth. We find that having a capital

structure that is more heavily tilted towards formal credit channels results in a greater

likelihood of success. This fact holds even when we include the credit score as a measure

of firm quality to guard against the possibility that unobserved factors drive both success

and credit access. Our findings indicate that even if credit conditions in 2004 were

unique, credit market access had an important impact on firm success.

This paper is related to a number of papers in the banking, capital structure, and

entrepreneurship literature. Given the emphasis in the current work on the role of

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formal banking channels, our paper is also related to the literature on the role of banks

and other sources of financing for small firms (Peterson and Rajan, 1994, 1997, 2000).

Finally, we also speak to a literature in entrepreneurship that focuses on the role outside

financing alternatives to help firms grow.3

The remainder of the paper is as follows. We begin in Section 2 by describing the KFS

in greater detail. Section 3 examines initial capital structure choices. We incorporate

credit scores and other firm characteristics in Section 4. Section 5 explores multivariate

regressions of capital structure on a range of business and owner characteristics to explain

capital structure decisions. In Section 6 we examine how initial capital structure affects

firm outcomes. Section 7 concludes.

2 The Kauffman Firm Survey

The KFS is a longitudinal survey of new businesses in the United States. This survey

collected information on 4,928 firms that started in 2004 and surveys them annually.

These data contain detailed information on both the firm and up to ten business owners

per firm. In addition to the 2004 baseline year data there are three years of follow up

data (2005 through 2007) now available. Additional years are planned. Detailed infor-

mation on the firm includes industry, physical location, employment, profits, intellectual

property, and financial capital (equity and debt) used at start-up and over time.

Information on up to ten owners includes age, gender, race, ethnicity, education,

previous industry experience, and previous startup experience. For more information

about the KFS survey design and methodology, please see Ballou et. al (2008). A

public-use dataset is available for download from the Kauffman Foundation’s website

and a more detailed confidential dataset is available to researchers through a secure,

3For a noteworthy recent example of the role of outside capital in entrepreneurship decisions, seeCosh, Cumming and Hughes, 2008. Gompers and Lerner, 2001, provide an excellent summary of venturecapital. Wong, 2003, is one of the first treatments of angel investing.

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remote access data enclave provided by the National Opinion Research Center (NORC).

For more details about how to access these data, please see www.kauffman.org/kfs.

A subset of the confidential dataset is used in this research—those firms that either

have data for all three survey years or have been verified as going out of business in 2005,

2006 or 2007. This reduces the sample size to 3,972 businesses. The method we used for

assigning owner demographics at the firm level was to define a primary owner. For firms

with multiple owners (35 percent of the sample), the primary owner was designated by

the largest equity share. In cases where two or more owners owned equal shares, hours

worked and a series of other variables were used to create a rank ordering of owners

in order to define a primary owner. (For more information on this methodology, see

Ballou et. al, 2008). For this research, multi-race/ethnic owners are classified into one

race/ethnicity category based on the following hierarchy: black, Asian, other, Hispanic,

and white. For example, an owner is defined as black, even if he/she is also Hispanic.

As a result of the ordering, the white category includes only non-Hispanic white.

Tables 1 and 2 provide details on business characteristics. In Table 1, we report

key features of the business—its legal form, location, and other features of operations.

Roughly 36% of all businesses in the data are sole proprietorships, and about 58% are

structured to provide some form of limited liability to owners. About 28% are organized

as S or C corporations.

Half of the businesses in the survey operate out of the respondents home or garage; the

vast majority (86%) market a service, and only a quarter of the firms in the survey have

any form of intellectual property (patents, copyrights, and/or trademarks). Reflecting

the fact that they are being measured at their inception, the firms are also tiny by almost

any conceivable measure. Nearly 60% of the firms have no employees other than the

founder, and less than 8% of firms in the sample have more than five employees in their

first year of operations.

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Table 2 considers the cash flow characteristics of these nascent businesses. Even

though these firms are small, nearly twenty percent of firms (16.8%) have over $100,000

in revenue in their first year. Indeed, 45% of the firms in the sample have more than

$10,000 in annual revenue in their first year. Of course, over 57% of firms have more

than $10,000 in expenses, and almost one firm in four reports zero profit or loss.

Table 3 examines owner characteristics in more detail. The entrepreneurs in our

data are overwhelmingly male and white: less than one-third of respondents are female

and over three-quarters are non-Hispanic white. In spite of the fact that most of the

businesses in our data begin at home, in people’s garages, with fewer than five employees,

the overwhelming majority of business owners have at least some industry experience.

Less than ten percent of owners have no previous industry experience, while more than

half have more than five years of industry experience. Likewise, more than forty percent

of business owners have started a business before. More than 80% of respondents are

over the age of 35 when they start their business, and roughly half the sample is aged

45 or older.

The entrepreneurs in our sample are relatively well educated. Less than 20% of re-

spondents have less than a high school degree, while well over half of respondents have

completed some form of a college degree. Finally, nearly a quarter of all respondents

have received some form of advanced, post-graduate education. In broad terms, these

demographics match those reported in other data sources. For example, these demo-

graphics are similar to those reported in Puri and Robinson (2008), using the Survey of

Consumer Finances, and Fairlie and Robb (2007), using the Characteristics of Business

Owners Survey.

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3 A New Pecking Order?

The standard prescription from pecking order models is that firms first should use inter-

nal cash, then rely on debt financing, and then rely on equity financing. Of course, most

capital structure models implicitly assume an owner-managed firm but are most often

tested using large, well established firms. How well do capital structure theories describe

how beginning firms actually make their initial financing decisions? In this section we

begin to answer this question by describing the capital structure decisions of startup

firms.

To impose some structure on the details of startup fundraising, we group fundraising

choices along two dimensions. First, we distinguish owner financing, informal financing

and formal financing. We also distinguish debt from equity. Owner financing takes the

form of loans or equity positions in the firm that derive specifically from the owner’s

personal wealth. Informal financing channels include debt or equity from family members

and personal affiliates of the firm, while formal financing channels include debt accessed

through formal credit markets as well as venture capital and angel financing.

3.1 A detailed look at capital structure

In Table 4, we provide a detailed look at the capital structure choices that nascent

firms make. It provides a breakdown of thirty different sources of capital for startup

businesses. Over 75% of firms have at least some owner equity; of these, the mean

amount is just over $40,500. If we include the quarter of firms with no reported owner’s

equity, the average owner equity amount drops to $31,734.

Owner debt plays a much smaller role. Only about 1/4 of firms have some form of

owner personal debt, and the vast majority of this is mostly in the form of debt carried

on an owner’s personal credit card. The overall average amount of credit card debt used

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to finance startups is a modest $5,000, but this includes the roughly 75% of owners

who do not use personal credit cards to start their businesses. Among those who do,

the balance is considerably larger—$15,700, or about 1/3 of the size of owner equity.

But in general, personal credit card balances make up a relatively small fraction of the

startup’s overall capital structure at inception—only about 4 to 5% of the firm’s total

capitalization is in the form personal credit card balances held by firm owners.

While the owner-level capital structure is heavily tilted towards equity, the capital

structure of insiders and outsiders is completely reversed. If we include the firms with

zero values, firms use about five times as much debt as they do equity. This holds for

both inside debt ($6,362) to equity ($2,102), as well as outside debt ($47,847) to equity

($15,935). But seven times as many firms report outside debt as report outside equity.

Yet, among those who do receive outside equity, there is no question that it is important.

The average amount of outside equity among the 205 firms who access this source of

financing is over $350,000, roughly twice as large as the total financial capital for the

average firm in the survey.

Turning first to insiders, we see that equity is uncommon. Only about five percent

of the sample relies on equity from a spouse or other family members, and the overall

average amount (including the 95% with no family equity) is only about two percent

of the average funding. Yet, among the group who uses family equity, the source is

important: the magnitude of insider equity is roughly the same as that of owner equity,

and many times larger than the magnitude of owner debt.

Insider debt is more common, but still a small source of funding relative to outside

debt and equity. The mean value of inside debt for all firms is $6,362, and this primarily

comes from personal loans received by the respondent from family and other owners.

Loans directly to the business from owners or other family members are also important,

but the fact that less than ten percent of surveyed firms rely on any one type of inside

debt suggests that this funding source is not commonly relied upon by new firms.

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When we turn to outsider debt, we see that on average it is the largest single financing

category for startups during their first year of operation. While this no doubt reflects

the relative supply of outside debt to other funding sources, it is noteworthy that only a

relatively small fraction of this comes from credit card balances issued to the business.

Of the $47,847 average debt level, less than $2,500 on average comes from business credit

cards.

One widely held view about entrepreneurial finance is that startups lack access to

formal capital markets, and thus are forced to rely on an informal network of family,

friends, and other financing sources like credit cards to bootstrap their initial financing.

Table 4 speaks against this idea. First, outside capital is extremely important, even at

the earliest stages of a firm’s life. The average new firm has approximately $109,000 of

financial capital. Of that, roughly half comes from outside sources.

To be clear, however, informal investors do play an important role for those firms who

obtain external equity funding. Looking solely at the external equity funding, of the 205

firms who received some form of external equity funding, over half received funding from

outside informal investors. The average amount, around $245,000, is roughly one-fourth

the average for the handful of firms that report obtaining venture capital.4

Second, the vast majority of this outside capital comes in the form of credit, either

through personal loans made directly to the owner or through business credit cards.

Moreover, credit cards play a relatively small role for the average startup. If we total

the average credit card holdings on all personal and business accounts associated with

the business, the amount sums to less than half the average personal bank loan. If we

tally the average personal bank loan and the average business bank loan, this amount is

roughly four times the size of the average total credit card balances outstanding.

4Some firms may indeed misclassify angel investors as venture capital, as the average amounts arequite low.

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In some respects, these descriptive statistics suggest that pecking order does a good

job of describing the capital structure decisions of new firms. If we treat owner debt

and equity as internal funding, and abstract away from its capital structure, then we

see that many firms rely on internal funding, fewer firms rely on debt, and fewer firms

still rely on equity. This broadly conforms to the basic message of the Myers and Majluf

pecking order. At the same time, this characterization misses important details, because

it abstracts away from the interaction between capital choice (debt vs. equity) and from

whom to raise capital—whether the capital comes from insiders or outsiders.

3.2 Capital Structure and Firm Type

Perhaps the most surprising finding in Table 4 is that formal credit channels—business

and personal bank loans—are the most important sources of funding for startups. To

push this observation further, we segment the data in Table 5 to report capital structure

patterns for different types of startup firms.

The idea behind Table 5 is to isolate those firms that are in their very earliest stages

of starting up, to see if the overall capital structure patterns hold there as well. This can

be done according to a number of criteria. In the first column of Table 5, we examine

the 2,425 firms who have no employees other than the founder. These firms are small

relative to the average reported for all firms in Table 4—there total capital is only around

$45,000 as compared to the roughly $110,000 in Table 4. But proportionately, outside

debt plays a quite similar role: the average non-employer firm has $19,500 in outside

debt, or about 43% of its total capital, compared to approximately $48,000, or about

44% of total capital on average for firms overall. Of the outside debt, we again see that

business bank loans and personal bank loans make up the bulk of the $19,500. Only

about $2,500 comes from other sources on average.

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The second column examines the 2,168 businesses which are home-based, meaning

that they do not operate any office or warehouse space outside the home. These too are

small, presumably including the proverbial “garage business” as well as businesses of a

professional nature that operate out of a home office. The capital structure patterns

for these businesses are remarkably similar to the non-employer businesses: about forty

percent of their total capital is financed through outside debt, and the lion’s share of

that comes from personal and business bank loans, rather than credit card balances.

Another way to pinpoint firms at their earliest stages is to focus only on pre-revenue

or pre-profit firms. We examine these firms in columns (3) and (4), respectively. These

firms are considerably larger than the previous two categories, presumably because these

include many firms that have secured inventories in advance of sales, or require external

building space to operate. Indeed, these columns look quite similar to the averages

reported in Table 4 for the whole sample.

Because the first four columns of Table 5 monotonically expand the size and scope of

firms under consideration, they offer an alternative way to examine pecking order and

access to capital, albeit descriptively. Moving from the first column of data to the fourth

column of data more than doubles the firm’s size by adding an additional $80,000 of total

capital to the firm. By far the bulk of this comes from outside debt and equity, which

together make up about half the increase in firm capital. Since columns (3) and (4)

also contain some non-employer and home-based firms, this comparison understates the

magnitude of the shift in capital structure. Thus, the comparisons across the columns of

Table 5 indicate that friends and family is probably an earlier source of financing than

outside debt, as previous accounts have indicated. It is just not terribly important in

terms of total size.

The final two columns of Table 5 split the data according to whether the firm con-

tinued to operated throughout the first four waves of the KFS, or whether the firm

ceased operations. Firms that survive look very much like the overall average reported

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in Table 4. On the other hand, firms that ceased operations sometime before 2007 not

only began smaller, but also had considerably smaller proportions of outside debt to

total capital. Of course, it is impossible to draw any causal connection between these

two observations, but in the next section we can examine causation more carefully by

considering how credit quality affects these findings.

4 Firm Quality and Capital Structure Decisions

4.1 Credit worthiness, technology and pecking order

Table 6 takes the richness of Tables 4 and 5 and boils it down to six categories: owner

debt, owner equity, inside debt, inside equity, outside debt, and outside equity. These

classifications are as described in the left-most column of Tables 4 and 5. Reducing the

amount of detail not only makes the pecking order that most firms use more apparent,

it also facilitates more comparisons across different types of firms.

The rows of Table 6 are arranged from highest to lowest in terms of the overall

weighted average level of 2004 funding. If we interpret the magnitudes as an indication

of relative importance, then we see a clear pecking order emerge: first outside debt, then

owner equity, then debt from insiders. Fourth in the pecking order is outside equity,

followed by owner debt; the least used source is inside equity.

An alternative way to characterize the pecking order of nascent firms is to combine

owner debt and equity into a single category, internal funding. Looking at capital

structure this way, the average firm is roughly equal parts internal funding and outside

debt. These two sources of funding are each roughly four times larger than the next

largest source of financing. Regardless of how the financial pieces are assembled, outside

debt plays a paramount role in funding newly founded firms.

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One reason for this may simply be that outside debt is more plentiful than other

sources of funding. To explore this possibility, we obtained commercial credit scores

for each firm to identify high credit worthiness and low credit worthiness firms. Table 6

shows that while high credit worthiness firms have access to much more financial capital,

they access capital in roughly the same proportions as low credit worthiness firms. Thus,

a firm’s credit score induces a first-order shift in the level of financing it obtains, but

only a second-order shift in capital structure choice it makes.

Outside equity plays a substantially more important role in the capital structure of

high tech firms. Across all high tech firms, outside equity is the third largest funding

source behind outside debt and owner equity. Among high tech firms with high credit

scores, outside equity is the largest form of financing. It is only the low credit score

firms in the high tech sector that display a pecking order that resembles the average

firm in the data—but even for those firms, owner equity is a more important source of

financing than outside debt.

4.2 Separating credit supply from credit demand

To separate credit supply and credit demand, we exploit the availability of credit score

information to identify cases in which firms faced unexpectedly easy or difficult access

to capital. If the capital structure choices depicted in the previous tables are polluted

by differences in the availability of capital, then this should control for that.

To account for this possibility, we regress the firms credit score on variables that

proxy for demand-side factors that would influence credit ratings. We consider two

models. First, we run the following regression:

scoreij = α + βj + εi (1)

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where scoreij is the credit score of firm i in industry j, βj are industry fixed effects.

Thus, the first estimation simply includes a set of 60 industry dummies.

For the second specification, we run the following regression:

scoreij = α + βj + γ1Fij + γ2Kij + εi (2)

where scoreij is the credit score of firm i in industry j, βj are industry fixed effects, and

F is a vector of owner characteristics, and K is a vector of firm characteristics, both

of which likely vary with demand for credit. For this specification, we include a full

set of industry dummies, a set of education dummies corresponding to the breakdown

presented in Table 3, and we also include factors such as race, ethnicity, industry ex-

perience, intellectual property, legal structure of the enterprise, whether the business is

home-based, and whether the business sells a product or provides a service. While these

coefficient estimates are interesting in their own right, a full discussion is beyond the

scope of this paper. Indeed, in Robb, Fairlie and Robinson (2009) we explore the issue

of race and access to credit in greater detail.

The idea behind both specifications is that by purging the credit score of variation

that is linked to factors driving the demand for credit, the remaining variation in credit

score would reflect supply-side credit restrictions. Firms with high unexplained credit

scores should have easier access to capital, while firms with low unexplained credit scores

should have relatively more difficult access to capital. Moreover, the differences in their

access to capital should reflect suppliers willingness to lend, rather than differences in

capital needs.

Recovering the regression errors from these two models gives us a mechanism for

classifying firms as credit constrained or unconstrained. Of course, a firm with a low

unconditional credit score is constrained, but this low score may arise endogenously

because the firm has little need for external capital, low growth prospects, and therefore

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does not take the steps needed to boost its credit score. By relying on the conditional

credit score as opposed to the raw credit score, we circumvent these problems.

Tables 6 and 7 report pecking orders for firms in the lowest and highest quintiles

of the unexplained credit score distribution. Firms in the lowest quintile face the most

severe unexplained restrictions to credit access, since their credit scores are much lower

than would be predicted based on their demand characteristics. In contrast, the top

quintile have the easiest access to credit, since they have high unexplained credit scores,

given their access to capital.Table 6 presents the detailed classification of funding sources,

while Table 7 presents the aggregated data.

In general, the results of Tables 6 and 7 mimic the results from the previous table,

in that they show a first order affect on the amount of capital raised, but only a second

order effect on capital structure choice. Credit constrained firms have capital structures

that look very similar to those of unconstrained firms. The primary difference is that

unconstrained firms have much higher levels of capital investment.

5 Explaining Funding Decisions

Having described initial capital structure choices in detail, we now turn to the task of

explaining the observed variation in capital structure choice. We do this in Table 11,

where we regress capital structure ratios on owner and firm characteristics. In general,

Table 11 reports OLS regressions of the following form:

Financing Category

Total Capital= α + βj + γ1Fij + γ2Kij + εi (3)

where βj are industry fixed effects, F is a vector of owner characteristics, and K is

a vector of firm characteristics. The dependent variable in each column is a financial

ratio—either outside debt, outside equity, outside loans, or inside finance—each scaled

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by the firm’s total capital. (The unmeasured category is the ratio of owner financing

to total capital.) Outside loans are a subset of outside debt that include only personal

bank loans and business loans. The firm characteristics include not only the survey

characteristics described in Tables 1-3, but also the firm’s credit score, a measure of

quality that might well be unobserveable to the econometrician in other circumstances,

but would be readily observable to credit market participants.

Do gender and race play a role in determining initial capital structure choices? Table

9 suggests that this is definitely the case. First, gender: women receive significantly less

outside capital than other groups. The results for women indicate that the average

female-owned business holds about 5% less outside debt than the same male-owned

business. Although these results may reflect the fact that women face more restricted

access to capital in the credit market, the data do not allow us to rule out the possibility

that, notwithstanding the industry fixed effects, female-owned businesses simply may

demand less outside capital, perhaps because they are more likely to be second-income

businesses.

Next, the question of race. Table 9 shows that black-owned businesses hold much

less outside debt in their initial capital structure than other businesses. The magnitudes

are similar to those found for gender: the ratio of outside debt to total capital is about

13% lower for black-owned businesses than for otherwise equal white-owned businesses.

Whether this attributable to supply-side or demand-side considerations, it is important

to note that these regressions hold constant the industry of the business, the firm’s

credit quality, the owner’s education, and their prior industry and startup experience.

Thus, unobserved heterogeneity in underlying business quality seems unlikely to be a

first-order explanation for the difference.

We also observe other racial differences in capital structure choice. Hispanics and

Asians, but not Blacks, rely heavily on inside finance.5 While Hispanic or Asian ethnicity

5This is measured as the sum of inside equity and debt.

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explains little variation in access to external capital, these groups average about 25%

more inside capital in their total capital structure. Given that the average firm in Table

4 has an inside-to-total capital ratio of around 12%, this effect is enormous in economic

magnitude, representing a 75% increase in the average amount.

Across the board, increasing hours worked in the business is associated with greater

outside and inside capital, and consequently, lower owner financing. Similarly, owner

age has an increasing but concave relationship with access to external capital, for both

debt and equity, while it has the opposite relationship for inside financing.

Prior experience plays an interesting role in determining initial capital structure.

Owners with prior startup experience tend to rely on external equity more than others.

In contrast, Table 9 indicates that owners with more industry experience rely signifi-

cantly more on their own financing, since the association between industry experience

and capital type is negative across all types reported in the table.

The regressions also include, but do not report, owner education. Different categories

of education have similar experiences accessing external debt equity, but there is a

pronounced effect associated with inside financing. Namely, those who do not finish

high school are significantly more likely to rely on inside financing than other groups.

Since the regressions include industry fixed effects, it is not the case that this is driven

by sorting of low education respondents into industries with low capital requirements.

Rather, this is probably an indication that lower quality businesses are more likely to

rely on inside financing instead of accessing external capital markets.

The business characteristics reported in the bottom of the table demonstrate that

firms with lower asymmetric information problems enjoy more ready access to external

capital sources, and in particular, external credit funding. Home-based businesses rely

more heavily on owner financing, while firms with multiple owners have larger fractions

of outside-to-total capital. Comparing the point estimates in Table 11 to the averages

in Table 4 suggests that multiple-owner firms receive about a ten percent increase in

18

the baseline amount of outside debt, and about a 25% increase in the baseline level of

external equity (from around 8% to around 10%). Firms that have intellectual property

are not more likely to access outside debt, but are more likely to access external equity,

than those that do not.

6 Does Financial Access Affect Survival?

It is widely noted that startup firms are a key driver of growth in our economy. How

then, do capital structure choices affect the growth of startup firms? This question is

important for two reasons. First, the question provides normative implications for credit

market access. Second, the question provides an important robustness check against the

possibility that our main finding of interest—the fact that startups rely extensively on

external credit markets to fund their early life—is being driven by peculiarities in the

credit market in 2004. If our findings simply reflect the fact that credit was readily

available in 2004, then there is no reason to believe that access to external credit should

affect firm success.

To take up this question, we report Probit analysis of three key measures of growth

from 2004-2007. First, we create a dummy for whether a firm has above median rev-

enues in 2007. Then we repeat this calculation for profits and for employees. Our key

explanatory variable is the ratio of outside debt to total capital. The hypothesis that

we are testing is that firms with greater levels of external capital had better growth

prospects.

Table 12 tests this hypothesis. It includes the same basic set of owner and firm

characteristics, plus the ratio of outside debt to total capital and the level of 2004 sales.

The outside debt ratio has a positive and highly significant effect on revenue growth and

employee growth, but a statistically insignificant positive effect on profit growth.

19

To attach a causal interpretation to these findings, it is important to control for

unobserved characteristics that might affect access to debt and success. In that regard,

including the credit score and other firm characteristics are essential for our findings.

Including the credit score allows us to conclude that controlling for firm creditworthiness,

firms that accessed more external debt were nearly ten percent more likely to be in the

top revenue group, and nearly six percent more likely to have hired employees. Note too

that this also controls for the initial revenues the firm experienced in 2004, therefore the

effect is not attributable to initial size. Table 12 indicates that, indeed, initial capital

structure decisions are important for firm success.

The owner and firm characteristics, which are included as controls in Table 12, are

interesting in their own right and raise many questions for future research. First, they

show that female-owned businesses are significantly less likely to grow than male-owned

businesses. Black-owned businesses are significantly less likely to have grown in terms

of profits or sales, but they are more likely to have added employees than white-owned

businesses. Asian-owned businesses are also more likely to have added employees, al-

though Asian ownership is unrelated to revenue or profit growth. And finally, the vector

of firm characteristics that might describe a firm, a priori, as a lifestyle business or not

indeed predicts whether a firm has grown.

7 Conclusions

This paper uses a novel data set to explore the capital structure decisions that firms

make in their initial year of operation. In the vast majority of cases, this is when the

firms in question are still being incubated in their founders’ homes or garages, before

outside employees have joined the firm in any significant number, and certainly well

before the firms in question would be attractive to the types of funding sources that are

the focus of most discussions of early stage financing.

20

In spite of the fact that these firms are at their very beginning of life, they rely to

a surprising degree on outside capital. The notion that startups rely on the beneficence

of a loose coalition of family and friends seems misleading given our findings. While the

data suggest that informal investors are important for the handful of firms that rely on

outside equity at their startup, the data also indicate that most firms turn elsewhere for

their initial capital. Indeed, roughly 80-90% of most firms’ startup capital is made up in

equal parts of owner equity and bank debt. The fact that the debt is financed through

arms length relationships, and not through family and friends networks, is worthy of

further research.

To be sure, our findings underscore the importance of liquid credit markets for the

formation and success of young firms. If startups hold the key to growth in western

economies, then surely economic growth hinges critically on the smooth functioning of

credit markets that enable young firms to be formed, to grow, and to succeed. Indeed,

if we extrapolate a bit, our findings suggest that the financial crisis that started in the

housing market will be especially problematic for financing startups. While an economic

crisis may increase the supply of potential entrepreneurs in the short-run, through job

losses in other areas, the collateral restrictions implied by the dramatic collapse in hous-

ing prices should impair to a major source of capital for startups. Financial constraints

facing startups, long thought to be acute, even in boom times, will almost surely be

more acute going forward.

21

References

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beginning: persistence and the cross-section of corporate capital structure,” Journal

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[10] Myers, Steward and Nicholas Majluf, 1984. Financing and investment decisions

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tion, University of Chicago.

23

Table 1: Business CharacteristicsWeighted

PercentageBusiness Legal Status

Sole Proprietorship 0.360Partnership 0.057Corporation 0.277

Limited Liability Corporation 0.306

Business LocationHome Based 0.500

Leased Space 0.396Other 0.104

Business Product/Service OfferingsService Offered 0.858

Product Offered 0.516Business Offers Both Service(s)/Product(s) 0.378

Intellectual PropertyPatents 0.022

Copyrights 0.086Trademarks 0.137

Employment SizeZero 59.2

1 14.02 9.13 4.6

4-5 5.86-10 3.911+ 3.6

Credit ScoreHigh Credit Score 0.115

Medium Credit Score 0.553Low Credit Score 0.332

Source: Kauffman Firm Survey Microdata. Sample includes only survivingfirms over the 2004-2007 period and firms that have been verified as goingout of business over the same period. Sample size 3,972.

24

Table 2: Cash flow characteristics of startups in the KFSPanel A: Percent of Businesses by Revenues and Expenses

Weighted WeightedRevenues Percentage Expenses PercentageZero 35.3% Zero 6.7%$1,000 or less 5.1% $1,000 or less 8.5%$1,001- $5,000 7.7% $1,001- $5,000 16.0%$5,001- $10,000 6.1% $5,001- $10,000 11.3%$10,001- $25,000 10.5% $10,001- $25,000 16.2%$25,001- $100,000 18.6% $25,001- $100,000 25.3%$100,001 or more 16.8% $100,001 or more 15.8%

Panel B: Percent of Businesses by Amount of Profits or LossesWeighted Weighted

Profit (44.5 %) Percentage Loss (55.5%) PercentageZero 19.4% Zero 3.4%$1,000 or less 10.2% $1,000 or less 13.2%$1,001- $5,000 16.4% $1,001- $5,000 27.3%$5,001- $10,000 12.5% $5,001- $10,000 17.0%$10,001- $25,000 17.4% $10,001- $25,000 17.9%$25,001- $100,000 20.0% $25,001- $100,000 16.9%$100,001 or more 4.1% $100,001 or more 4.2%

Source: Kauffman Firm Survey Microdata. Sample includes only surviving firms over the 2004-2007 period and firms thathave been verified as going out of business over the same period. Sample size 3,972.

25

Table 3: Business owner demographicsWeighted Weighted

Characteristics Percentage Characteristics: PercentageMale 69.2Female 30.8 Industry Exp. (Yrs.)

Zero 9.8White 79.3 1-2 13.9Black 8.6 3-5 15.6Asian 4.2 6-9 9.9Others 2.3 10-14 13.6

15-19 11.3Non-Hispanic 94.5 20-24 9.3Hispanic 5.5 25-29 7.5

30+ 9.3Owner Age24 or younger 1.325-34 16.5 Previous Start-ups35-44 33.6 0 57.545-54 29.0 1 21.555 or older 19.6 2 10.2

3 5.0Owner Education 4 or more 5.8HS Grad or Less 13.9Tech/Trade/Voc. Deg. 6.4Some Coll., no deg. 21.8 Hours WorkedAssociate’s 8.6 Less than 20 18.5Bachelor’s 25.3 20-35 19.5Some Grad, No Deg. 5.9 36-45 14.3Master’s Degree 13.4 46-55 15.2Professional/Doctorate 4.7 56 or more 32.5Source: Kauffman Firm Survey Microdata. Sample includes only surviving firms over the 2004-2007period and firms that have been verified as going out of business over the same period. Samplesize 3,972.

26

Table 4: Sources of Financing for 2004 StartupsAll firms All >0 firms

Category Funding Source Mean Mean Count

Owner Equity $31,734 $40,536 3,093Owner Debt $5,037 $15,765 1,241

Personal CC balance, resp. $2,811 $9,375 1,158Personal CC balance, others $238 $7,415 132Personal loan, other owners $1,989 $124,124 67

Insider Equity $2,102 $44,956 177Spouse Equity $646 $40,436 62Parent Equity $1,456 $42,509 126

Insider Debt $6,362 $47,873 480Family Loan $2,749 $29,232 327

Family loan to other owners $284 $34,509 29Personal loan to other owners $550 $28,988 73

Other personal loans $924 $81,452 45Business loan by family $1,760 $57,207 115Business loan by owner $15 $9,411 5Business loan by emp. $79 $22,198 9

Outsider Equity $15,935 $354,540 205Other informal investors $6,350 $244,707 110

Business equity $3,645 $321,351 56Govt. equity $798 $146,624 27

VC equity $4,804 $1,162,898 26Other equity $337 $187,046 8

Outsider Debt $47,847 $128,706 1,439Personal bank loan $15,859 $92,433 641

Owner bus. CC balance $1,009 $7,107 543Personal bank loan by other owners $1,859 $80,650 92

Bus. CC balance $812 $6,976 452Other Bus. CC balance $135 $7,852 62

Bus. bank loan $17,075 $261,358 243Credit line balance $5,057 $95,058 210

Non-bank bus. Loan $3,627 $214,920 72Govt. bus. Loan $1,331 $154,743 34Other bus. Loan $231 $78,281 19

Other individual loan $226 $43,202 22Other debt $626 $119,493 22

Total $109,016 $121,981 3,536

Source: Kauffman Firm Survey Microdata. Sample includes only surviving firms over the 2004-2007 period and firms thathave been verified as going out of business over the same period. Sample size 3,972. The mean for all firms is reportedin the first column. The second column reports the mean for only firms with positive amounts of that source of funding.The sample size for that source of funding is reported in the third column.27

Table 5: Sources of Financing for 2004 Startups by Firm Type

Non- Home- Pre- Pre- Survived ClosedFunding Source Employer Based Revenue Profits thru 2006 by 2006

Owner Equity $17,269 $20,035 $31,201 $35,433 $31,784 $31,609Owner Debt $2,318 $2,624 $3,720 $5,445 $4,896 $5,392

Personal Credit Card -Owner $1,896 $2,093 $1,937 $3,499 $2,634 $3,256Personal Credit Card-Other Owners $159 $218 $133 $305 $217 $291

Insider Equity $698 $1,024 $2,271 $2,553 $1,705 $3,101Spouse Equity $270 $215 $612 $638 $468 $1,094Parent Equity $428 $809 $1,659 $1,915 $1,237 $2,007

Insider Debt $2,381 $3,074 $6,456 $7,852 $5,856 $7,635Personal Family Loan $1,051 $1,683 $2,451 $3,342 $2,437 $3,535

Personal Family Loan-other owners $194 $144 $260 $244 $220 $445Business Loan from family $350 $580 $2,114 $2,335 $1,481 $2,464Business Loan from Owner $0 $0 $3 $24 $5 $39

Other Personal Loan $475 $302 $1,233 $1,177 $1,191 $252Other Personal Funding $300 $366 $388 $598 $422 $873

Business Loan from Employee(s) $11 $0 $7 $130 $100 $27

Outsider Equity $2,774 $4,731 $16,268 $21,530 $18,753 $8,841Other Informal Investors $785 $2,489 $7,006 $9,704 $7,992 $2,218

Other Business Equity $1,529 $1,568 $4,539 $4,727 $3,840 $3,155Government Equity $10 $226 $550 $945 $1,083 $81

Venture Capital Equity $441 $443 $4,164 $5,618 $5,373 $3,373Other Equity $9 $5 $9 $537 $466 $14

Outsider Debt $19,353 $26,960 $44,839 $54,536 $50,087 $42,208Personal Bank Loan $11,453 $12,898 $12,962 $17,738 $17,416 $11,941

Business Credit Card $577 $561 $683 $1,094 $969 $1,107Other Personal Owner Loan $263 $314 $1,650 $1,641 $2,046 $1,845

Business Credit Card-other owners $25 $53 $44 $187 $100 $225Business Credit Cards $538 $460 $460 $946 $826 $776

Bank Business Loan $5,231 $9,180 $18,474 $21,160 $18,653 $13,103Credit Line $341 $656 $2,986 $4,823 $5,061 $5,047

Other Non-Bank Loan $296 $1,044 $4,970 $3,229 $2,311 $6,941Government Business Loan $58 $309 $1,925 $1,671 $1,514 $871

Other Business Loan $145 $324 $36 $232 $303 $52Other Bank Loan $369 $1,193 $1,316 $2,247 $2,045 $1,391

Other Individual Loan $146 $146 $15 $198 $236 $201Other Business Debt $176 $135 $967 $1,010 $655 $553

Total Financial Capital $44,793 $58,448 $104,755 $127,349 $113,080 $98,787Observations 2,425 2,168 1,615 2,144 3,390 773

Source: Kauffman Firm Survey Microdata. Sample includes only surviving firms over the 2004-2007 period and firms thathave been verified as going out of business over the same period. Sample size 3,972.

28

Tab

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29

Table 7: Do Equity-backed Firms Embrace or Eschew Debt?Each column in this table reports capital structure decisions for firms with different types of outside equity. Thus, thesample size of each column is reported in the third row of Table 4, in the “Outside Equity” section. Amounts are averagesover all firms that had the type of funding in the column header in 2004. Some subcategories are suppressed for brevity,but they are included in the totals reported in each category.

Source Angel VC Corporate Govt-OtherOwner Equity $116,792 $119,459 $105,062 $47,062

Insider Equity $12,948 $4,278 $5,346 $5,521Spouse Equity $1,080 $0 $3,507 $58Parent Equity $11,868 $4,278 $1,839 $5,463

Outsider Equity $328,999 $1,499,644 $515,051 $171,145Other Informal Investors $244,707 $126,811 $183,110 $9,901Other Business Equity $60,568 $209,130 $321,351 $4,335Government Equity $6,488 $804 $443 $110,147Venture Capital Equity $17,084 $1,162,898 $10,148 $229Other Equity $151 $0 $0 $46,533

Owner Debt $19,558 $9,949 $13,041 $5,450Personal Credit Card -Owner $4,877 $3,749 $7,686 $4,882Personal Credit Card-Other Owners $543 $24 $688 $568

Insider Debt $15,997 $32,365 $9,033 $3,109Personal Family Loan $8,196 $4,051 $4,008 $190Personal Family Loan-other owners $651 $0 $2,098 $257Business Loan from family $1,091 $0 $1,189 $2,662Business Loan from Owner $436 $0 $0 $0Business Loan from Employee(s) $22 $0 $0 $0Other Personal Loan $1,033 $15,862 $878 $0Other Personal Funding $4,567 $12,452 $860 $0Other Personal Owner Loan $14,139 $6,176 $4,668 $0

Outsider Debt $164,891 $628,398 $75,156 $96,030Personal Bank Loan $21,629 $286,853 $23,295 $8,046Business Credit Card $2,645 $3,736 $3,405 $546Other Bank Loan $10,416 $128 $6,513 $2,080Business Credit Card-other owners $209 $65 $1,068 $26Business Credit Cards $1,038 $5,654 $3,122 $632Bank Business Loan $67,728 $299,169 $28,882 $56,094Credit Line $25,590 $1,216 $5,855 $1,918Other Non-Bank Loan $17,359 $19,005 $2,752 $0Government Business Loan $352 $402 $0 $22,219Other Business Loan $32 $0 $192 $0Other Individual Loan $3,402 $12,170 $73 $420Other Business Debt $14,491 $0 $0 $4,049

Total Financial Capital $659,184 $2,294,093 $722,690 $328,316

30

Table 8: Time-series evidence on the importance of formal debtEach column in this table reports the average for the subset of firms with the characteristics described in the columnheader. Column classifications are based on 2004. Column 3 is the set of firms that are incorporated, have at leastone employee other than the founder, and have assets such as inventories. Home-based businesses are ones that reportoperating out of the founders’ home.

All Firm Has Outside Inc./Employees/ Home-basedFirms Equity Asset-backed Non-employers

Panel A: Initial (2004) Baseline

Owner Equity $31,734 $92,806 $72,170 $14,652Insider Equity $2,102 $9,205 $6,733 $658Outsider Equity $15,935 $354,540 $57,428 $3,086Owner Debt $5,037 $14,320 $12,730 $2,045Insider Debt $6,362 $12,825 $15,781 $2,129Outsider Debt $47,847 $179,710 $120,843 $21,802Total Financial Capital $109,016 $663,407 $285,686 $44,371

Panel B: First (2005) Capital Injection

Owner Equity $15,352 $41,040 $33,855 $4,795Insider Equity $1,782 $1,426 $4,992 $420Outsider Equity $19,718 $275,713 $70,438 $658Owner Debt $4,447 $7,712 $6,107 $1,849Insider Debt $5,423 $11,792 $11,494 $913Outsider Debt $45,237 $137,049 $102,092 $19,003Total Injection $91,959 $474,732 $228,978 $27,637

Panel C: Second (2006) Capital Injection

Owner Equity $10,540 $38,720 $27,599 $4,848Insider Equity $585 $770 $2,182 $34Outsider Equity $10,033 $79,265 $38,656 $2,284Owner Debt $3,159 $7,075 $7,519 $1,942Insider Debt $4,241 $12,103 $10,345 $584Outsider Debt $42,326 $309,176 $135,750 $16,055Total Injection $70,884 $447,109 $222,051 $25,746

Panel D: Third (2007) Capital Injection

Owner Equity $8,210 $23,817 $19,224 $4,674Insider Equity $1,029 $8,513 $4,710 $148Outsider Equity $7,801 $92,488 $38,496 $433Owner Debt $3,155 $10,370 $7,776 $1,852Insider Debt $3,394 $20,990 $12,908 $535Outsider Debt $35,706 $90,086 $105,758 $18,930Total Injection $59,295 $246,264 $188,873 $26,571

31

Table 9: Sources of Financing for 2004 StartupsModel 1 Model 2

residual quintiles: residual quintiles:Funding Source Top Bottom Top Bottom

Owner Equity $51,335 $22,112 $39,225 $29,187

Owner Debt $7,481 $3,352 $6,386 $4,376Personal Credit Card -Owner $2,854 $2,356 $2,836 $3,031Personal Credit Card-Other Owners $281 $435 $188 $620Other Personal Owner Loan $4,345 $562 $3,362 $725

Insider Equity $4,539 $1,589 $3,884 $1,907Spouse Equity $799 $713 $789 $919Parent Equity $3,740 $877 $3,094 $988

Insider Debt $10,852 $6,354 $10,991 $7,790Personal Family Loan $3,621 $2,823 $3,890 $3,036Personal Family Loan-other owners $256 $53 $480 $135Business Loan from family $4,671 $2,215 $4,433 $2,873Business Loan from Owner $0 $5 $0 $5Business Loan from Employee(s) $238 $11 $231 $11Other Personal Loan $1,233 $721 $1,177 $1,032Other Personal Funding $834 $526 $779 $697

Outsider Equity $45,089 $7,844 $23,797 $11,139Other Informal Investors $21,798 $1,223 $9,058 $1,549Other Business Equity $7,591 $2,115 $791 $3,818Government Equity $1,312 $438 $1,217 $647Venture Capital Equity $14,324 $2,697 $12,671 $3,584Other Equity $65 $1,371 $60 $1,541

Outsider Debt $89,329 $25,122 $73,079 $40,345Personal Bank Loan $26,911 $8,864 $23,794 $10,107Business Credit Card $1,203 $675 $1,291 $971Other Bank Loan $2,841 $2,332 $1,531 $3,237Business Credit Card-other owners $123 $188 $109 $269Business Credit Cards $1,113 $743 $985 $1,014Bank Business Loan $30,179 $8,954 $22,730 $17,106Credit Line $17,087 $1,453 $13,787 $2,625Other Non-Bank Loan $5,573 $1,142 $5,168 $2,029Government Business Loan $1,170 $260 $1,100 $2,359Other Business Loan $423 $8 $315 $17Other Individual Loan $604 $60 $564 $101Other Business Debt $2,102 $443 $1,706 $511

Total Financial Capital $208,625 $66,374 $157,361 $94,745

N 790 820 810 811

Robust standard errors in parentheses. 2-digit industry dummies and owner education dum-mies included. *** p<0.01, ** p<0.05, * p<0.1.

32

Table 10: Explaining Capital Structure Choices of Startup FirmsDummy for Raised Financing through:

Debt Equity Bank Loan Inside FinancingBlack -0.271* 0.344* -0.261 0.540***

(0.145) (0.193) (0.196) (0.175)Asian -0.123 0.0354 -0.117 0.520**

(0.209) (0.250) (0.233) (0.245)Other -0.0376 -0.0926 -0.258 0.546*

(0.259) (0.323) (0.312) (0.327)Hispanic 0.344* -0.0494 0.0192 0.568***

(0.191) (0.219) (0.214) (0.210)Female 0.0354 -0.0546 -0.134 0.0285

(0.0932) (0.111) (0.111) (0.126)Hours worked 0.0194*** 0.00649*** 0.00895*** 0.0197***

(0.00186) (0.00220) (0.00202) (0.00229)Age -0.0224 0.0167 0.0572* -0.0584*

(0.0245) (0.0276) (0.0319) (0.0320)Age2 0.000199 -0.000161 -0.000502 0.000425

(0.000259) (0.000291) (0.000339) (0.000344)Work Experience -0.0220*** -0.00827* -0.0183*** -0.0187***

(0.00414) (0.00489) (0.00505) (0.00627)Startup Experience 0.181** 0.0479 0.130 0.0965

(0.0829) (0.0998) (0.0980) (0.111)Multiple Owners 0.138 0.0864 0.342*** 0.134

(0.0848) (0.101) (0.0988) (0.115)Credit Score 0.00564*** 0.000830 0.0110*** 0.000606

(0.00184) (0.00224) (0.00216) (0.00242)Intellectual Property -0.115 0.0642 -0.0422 0.260*

(0.106) (0.132) (0.121) (0.136)Comparative Adv. 0.203** 0.236** 0.0336 0.121

(0.0854) (0.101) (0.104) (0.121)Sells product 0.0538 0.185 0.265 0.0620

(0.146) (0.180) (0.165) (0.199)Sells Prod. & Serv. 0.0508 0.0311 -0.0154 -0.00463

(0.136) (0.170) (0.147) (0.180)Observations 3807 3807 3807 3807Robust standard errors in parentheses. 2-digit industry dummies and owner educationdummies included. *** p<0.01, ** p<0.05, * p<0.1.

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Table 11: Explaining Capital Structure Ratios for StartupsRatios of Financing Source to Total Capital:

Bank debt Inside Finance Outside Debt Outside EquityBlack -0.166** 0.162** -0.127** -0.0512

(0.0827) (0.0681) (0.0600) (0.153)Asian -0.0553 0.246** -0.0380 -0.0135

(0.108) (0.101) (0.0814) (0.188)Other -0.0879 0.183 -0.0210 -0.0972

(0.143) (0.122) (0.0975) (0.350)Hispanic -0.00336 0.253*** -0.0129 -0.267

(0.0927) (0.0888) (0.0702) (0.203)Female -0.0586 0.0115 -0.0505 -0.260***

(0.0483) (0.0502) (0.0363) (0.0978)Hours worked 0.00267*** 0.00681*** 0.00267*** 0.00385**

(0.000897) (0.000895) (0.000675) (0.00157)Age 0.0265* -0.0267** 0.0228** 0.0509*

(0.0135) (0.0132) (0.00948) (0.0274)Age2 -0.000250* 0.000195 -0.000237** -0.000517*

(0.000142) (0.000142) (0.0000997) (0.000284)Work Experience -0.00671*** -0.00582** -0.00447*** -0.00181

(0.00212) (0.00241) (0.00161) (0.00382)Startup Experience 0.0536 0.0204 0.0162 0.0237

(0.0431) (0.0437) (0.0321) (0.0772)Multiple Owners 0.174*** 0.0471 0.137*** 0.684***

(0.0425) (0.0446) (0.0316) (0.0834)Credit Score 0.00436*** 0.000139 0.00355*** 0.000791

(0.000918) (0.000959) (0.000679) (0.00165)Intellectual Property -0.0524 0.0968* -0.0481 0.210***

(0.0507) (0.0521) (0.0380) (0.0805)Comparative Adv. -0.0189 0.0240 0.0197 -0.0690

(0.0456) (0.0491) (0.0344) (0.0815)Sells product 0.121* -0.00448 0.0527 -0.0725

(0.0729) (0.0792) (0.0545) (0.120)Sells Prod. & Serv. -0.0123 0.0236 0.00560 -0.0193

(0.0656) (0.0726) (0.0495) (0.103)Observations 3418 3418 3418 3418Robust standard errors in parentheses. 2-digit industry dummies and owner educationdummies included. *** p<0.01, ** p<0.05, * p<0.1.

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Table 12: Capital Structure Choices and Firm OutcomesDV is dummy for above sample median:

Revenue Assets Profits Employee2004 log Revenue 0.0843*** 0.0267** 0.0512*** 0.0313***

(0.0117) (0.0119) (0.0102) (0.0104)Outside debt ratio 0.420** 1.256*** 0.148 0.318*

(0.172) (0.214) (0.162) (0.165)Black -0.609*** -0.592*** -0.616*** 0.398*

(0.235) (0.215) (0.194) (0.209)Asian 0.455 0.149 0.276 0.547**

(0.282) (0.294) (0.250) (0.261)Other -0.741* -0.133 -0.226 0.620*

(0.381) (0.436) (0.382) (0.351)Hispanic -0.365 -0.505** -0.341 0.292

(0.263) (0.256) (0.246) (0.265)Female -0.597*** -0.572*** -0.351*** -0.278**

(0.132) (0.131) (0.117) (0.116)Hours Worked 0.0182*** 0.0202*** 0.00771*** 0.0164***

(0.00251) (0.00269) (0.00223) (0.00241)Work Experience 0.0179*** 0.00953 0.0162*** 0.0157***

(0.00598) (0.00602) (0.00523) (0.00545)Startup Experience 0.0540 0.151 -0.184* 0.229**

(0.117) (0.118) (0.104) (0.107)Multiple Owners 0.690*** 0.718*** 0.0396 0.382***

(0.115) (0.130) (0.107) (0.109)Credit Score 0.0149*** 0.0151*** 0.00863*** 0.0144***

(0.00248) (0.00275) (0.00226) (0.00233)Intellectual Property -0.00931 -0.0552 -0.532*** -0.103

(0.138) (0.151) (0.129) (0.130)Comparative Adv. 0.202* 0.196 0.162 0.0931

(0.121) (0.127) (0.109) (0.109)Sells Product -0.367* 0.118 -0.415** 0.0241

(0.207) (0.225) (0.186) (0.191)Sells Prod. & Serv. 0.405** 0.0772 0.174 0.146

(0.189) (0.209) (0.171) (0.176)Observations 2507 2507 2507 25072-digit industry dummies, owner age, age2, and education dum-mies included. Robust standard errors are reported in paren-theses. *** p<0.01, ** p<0.05, * p<0.1

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A Alternative Classification Schemes for Inside/Outside

Capital

The following tables change the classification scheme from formal vs. informal to per-

sonal vs. business to illustrate the importance of personal access to formal bank channels.

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Table 13: Reclassifying Personal and Business Debt: Overall LevelsEquity Source Average Debt Source Average

Total Personal Equity $31,734 Total Personal Debt $21,906Personal bank loan $15,859

Owner bus. CC balance $1,009Personal CC balance, resp. $2,811

Personal CC balance, others $238Personal loan, other owners $1,989

Total Insider Equity $8,452 Total Insider Debt $8,221Spouse equity $646 Family loan $2,749Parents equity $1,456 Family loan to other owners $284

Other informal investors $6,350 Personal loan to other owners $550Other personal loans $924

Business loan by family $1,760Business loan by owner $15Business loan by emp. $79

Personal bank loan by other owners $1,859

Total Outsider Equity $9,585 Total Outsider Debt $29,120Business equity $3,645 Bus. CC balance $812

Govt. equity $798 Other Bus. CC balance $135VC equity $4,804 Bus. bank loan $17,075

other equity $337 Credit line balance $5,057Non-bank bus. loan $3,627

Govt. bus. loan $1,331Other bus. loan $231

Other individual loan $226Other debt $626

Total Equity $49,771 Total Debt $59,247

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Table 14: Reclassifying Personal and Business Debt: Credit ScoresModel 1 Model 2

residual quintiles: residual quintiles:Funding Source Top Bottom Top Bottom

Owner Equity $51,335 $22,112 $39,225 $29,187

Owner Debt $37,062 $13,524 $32,699 $16,312Personal Credit Card -Owner $2,854 $2,356 $2,836 $3,031Personal Credit Card-Other Owners $281 $435 $188 $620Other Personal Owner Loan $4,345 $562 $3,362 $725Other Personal Loan $1,233 $721 $1,177 $1,032Other Personal Funding $834 $526 $779 $697Personal Bank Loan $26,911 $8,864 $23,794 $10,107Other Individual Loan $604 $60 $564 $101

Insider Equity $26,336 $2,813 $12,942 $3,456Spouse Equity $799 $713 $789 $919Parent Equity $3,740 $877 $3,094 $988Other Informal Investors $21,798 $1,223 $9,058 $1,549

Insider Debt $8,908 $5,295 $9,143 $6,330Personal Family Loan $3,621 $2,823 $3,890 $3,036Personal Family Loan-other owners $256 $53 $480 $135Business Loan from family $4,671 $2,215 $4,433 $2,873Business Loan from Owner $0 $5 $0 $5Business Loan from Employee(s) $238 $11 $231 $11Business Credit Card-other owners $123 $188 $109 $269

Business Equity $23,292 $6,621 $14,739 $9,591Other Business Equity $7,591 $2,115 $791 $3,818Government Equity $1,312 $438 $1,217 $647Venture Capital Equity $14,324 $2,697 $12,671 $3,584Other Equity $65 $1,371 $60 $1,541

Business Debt $61,692 $16,010 $48,613 $29,869Business Credit Card $1,203 $675 $1,291 $971Other Bank Loan $2,841 $2,332 $1,531 $3,237Business Credit Cards $1,113 $743 $985 $1,014Bank Business Loan $30,179 $8,954 $22,730 $17,106Credit Line $17,087 $1,453 $13,787 $2,625Other Non-Bank Loan $5,573 $1,142 $5,168 $2,029Government Business Loan $1,170 $260 $1,100 $2,359Other Business Loan $423 $8 $315 $17Other Business Debt $2,102 $443 $1,706 $511

Total Financial Capital $208,625 $66,374 $157,361 $94,745

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